The Derivative - Searching for Volatile Macro Environments with Alfonso Peccatiello, The Macro Compass

Episode Date: March 30, 2023

What was the short-lived SVB baking crisis all about?  Has it forced the Fed’s hand?  Are we done tightening? Lots of Macro questions so who better to dig into it with than the appropriately nicknamed Macro Alf. In this episode of The Derivative, we sit down with Alfonso Peccatiello, founder of The Macro Compass and owner of the wonderful Twitter handle @MacroAlf to discuss the challenges of generating alpha in a low-volatility environment.  Peccatiello shares his experience of working for ING Bank and managing the Treasury Department's investment portfolio, how regulatory forces have pushed the large players into what looks currently like the wrong investments. They explore the difficulty of generating more return by taking the same amount of risk, especially in a market where the last basis point of carry of risk premia available was the name of the game. Alfonso and Jeff also delve into the bond market's predictive ability (or maybe more fair to say inability) and its role in predicting the economy's future, the importance of risk management, and the blending of systematic and discretionary processes in making investment decisions. They emphasize the need to consider various factors when analyzing the bond market and interpreting its nuances, plus so much more! So sit back, relax, and get ready to learn valuable insights into investment and macro trading and the challenges faced in generating alpha in a low-volatility environment — SEND IT!  Chapters: 00:00-02:18 = Intro 02:19-14:54= It’s Alf! Regulatory schemes, Bond exposure, Macro volatility, & Quitting the bank 14:55-25:34= Real Estate: The largest asset class under pressure 25:35-35:38= The Macro Compass – Blending Risk appetite, Research & tools 35:39-50:39= The fall of SVB: regulations, funding & risk management & The Swiss Credit Suisse 50:40-01:02:48= Off the Radar: China & its reopening From the Episode: Fed Pricing chart Follow Alfonso on Twitter @MacroAlf and check out his research, podcasts, and more at ⁠TheMacroCompass.com and subscribe! Don't forget to subscribe to ⁠⁠The Derivative⁠⁠, follow us on Twitter at ⁠⁠@rcmAlts⁠⁠ and our host Jeff at ⁠⁠@AttainCap2⁠⁠, or ⁠⁠LinkedIn⁠⁠ , and ⁠⁠Facebook⁠⁠, and ⁠⁠sign-up for our blog digest⁠⁠. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit ⁠⁠www.rcmalternatives.com/disclaimer

Welcome to the Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Hello there. It's the final four, then master's weekend, then warmer weather here in Chicago. So I'm excited but actually it's been a rather warm winter all over sending nat gas down about 70 percent over the last year uh so we're going to bring on our pal brent belote of kaylor capital he's one of the managers highlighted in our rankings white paper next week to talk through what's happening in that gas and the rest of the energy sector. So go subscribe and sign up to get that episode as soon as it drops.

On to this episode, and speaking of warmer weather, our guest today, MacroAlf, calls the south of Italy home, and with that slower lifestyle, his banking background, and his macro chops, I thought he would be a great guest to help take a step back after all the dust has settled and help us unpack what now looks like a rather short-lived banking crisis here in the U.S. We talk European banks just letting young traders like him have a risk budget, whether there is a banking crisis here in the U.S., what the Fed's next move may be, why and how nearly all predictions of future rates are wrong, and of course, his life of pizza on the beach. Send it. This episode is brought to you by RCM and their newest Managed Futures rankings.

We highlight top managers across all sorts of metrics, top by return, by risk, by risk adjusted, and more, and then give you a top 15 ranking. Go to rcmalts.com slash rankings to check it out today. And now, back to the show. All right, everybody. We are here with Alfonso Peccatiello. How did I do? Very well, Jeff. Very well. And now, I got to know, do you go by Alfonso Peccatiello. How did I do? Very well, Jeff. Very well.

And now I got to know, do you go by Alfonso or Alf? Alf. Alf, I love it. And I have to ask, because I'm a child of the 80s, did you ever watch the TV show, Alf, with the alien? I'm too young for that, but I've been referred to, for many people, to that Alf alien thingy, yeah.

We watched it with the kids a couple episodes during COVID and they're like, this is stupid. What are we watching? Like it's a Muppet trying to. Yeah. So we'll find an episode or two and send it to you. All right. But thanks for joining us. We're recording here 845 a.m. on March 24th, which I usually don't get into.

But we might say some stuff that is no longer relevant by the time this is released next week. So I wanted to lay that out there. It's your afternoon. You're in the beautiful South of Italy. That's correct. I am in a place very close to the Amalfi Coast, which involves great weather, great food, and a lot of other things which aren't particularly great. But overall, it's where I was born and that's the place I like. So born and raised and done all your work there in South Italy? Born and raised in the South of Italy, close to the Amalfi Coast. Then went to study in Germany, worked between Germany and the Netherlands, running money for ING Bank for eight years. And now I basically run my own macro strategy, investment strategy firm, which means I can do it from wherever I want, which happens to be very often exactly where

I was born and raised. I saw your tweet the other day with a beach, little pizza. That looked nice. We'll come visit. So you mentioned the bank. Tell us how all that came to be. And we were just talking offline a little bit of how they said run this book, which was a bit surprising to me. So give us the backstory there. So look, Jeff, I was working for the treasury department of ING Bank, which is a bank headquartered in the Netherlands, north of Europe, but actually it's a global bank. It's in Australia, it's in Poland, it's in the US. It's really a global bank. It's been quite a nice ride, a very wide range of experience from running interest rate risk to FX to credit to any sort of risk, really. I mean, the treasury department of such a bank is gigantic and it's

really involved in all the aspects of a bank, including what's turning out to be now the focus of everybody, which is these regulatory liquidity books that have been basically put in place after the great financial crisis. This large investment portfolio, mainly consisting of treasuries, but also mortgage backed securities and all this kind of government guaranteed liquid paper for regulatory purposes. I was in charge of a very large book that mostly comprised of that, but also I had overlay mandates effectively, which were something resembling a total return global macro book at the end of the day.

The reason is, look, between 2014 and 2021, people seem to have forgotten that, but interest rates were negative in Europe, negative in Switzerland, negative in most of continental Europe, and elsewhere, they were zero at best. So in that environment, as a bank, especially in Europe, you can't pass negative deposit rates to your customers. It's very, very hard to do so, which means you're sitting on negative net interest margin on a running basis because you can't charge your customers negative deposit rates. Your risk-free assets are negatively yielding, bonds, AAA bonds, all these liquid investments that the regulation requires you to have,

which means, wow, you're bleeding carry basically to meet regulation, which meant a lot of these banks try to find creative ways to generate additional return. And these overlay books were sometimes quite popular to try and generate some total return on top of that, interestingly, in a very low volatility environment back then for most of the time. So the answer to who in the world would accept negative rates was really nobody. They were there, but they weren't accepting them. They were trying to obfuscate them and change them internally. Look, it creates wrong incentive schemes, Jeff, because you are sitting on a regulatory scheme you cannot avoid, where by regulation you can't charge negative deposit rates to your customers.

In most cases, that was the situation in Europe. to own about 15, 20% of your balance sheet in liquid assets that are yielding as well, negative, even if you swap away interest rate risk and you buy these bonds in so-called asset swap. So you buy the bond, you pay fixed swap against it. You're only left with the credit spread in it. That also was very compressed because of ongoing quantitative easing across the board. So you basically didn't have a way to make money, neither from interest rate carry, nor from credit spread carry.

You had a little bit left in it. Just, it was basically like picking pennies in front of a steamroll, literally, because all this volatility event could wipe out years of carry that you had locked in. Such carry was that low. So you were forced to find creative solutions. And so what banks did is something that will probably come to haunt them,

I think, a bit over the next few quarters, which is, A, take more carry risk. And that meant more credit risk, which means, you know, you move to commercial mortgage-backed securities, mezzanine tranches. You move down the credit spectrum at the end of the day. You try to take more risks and try to capture more credit spreads by moving down the credit spectrum. And now it might turn to be a problem when you move in the part of the cycle, which is late stage or towards a recession, this exposure comes to haunt you. The other was to try and be more creative with the

risk you take. So rather than taking beta risk, try to create some alpha by having overlay exposures in your portfolios. Just popped in my head there, which came first? It's like a chicken or the egg, right? If they change these rules, you had to have all that securities. was the demand by all these depositors for those securities because of those rules drove rates down? Marco Cappellino, Well, look, it's always difficult to say what drove what. The reality is that inflation was really low between 2014 and 2021. You didn't have a lot of macro volatility, really, neither in growth nor in inflation. There was no cycle, Jeff. So what happened is by definition, you have

risk-free rates and term premium very compressed. You have central banks trying their best to revive the credit growth, revive the economy through quantitative easing programs. You have banks that by regulation are forced into piling into these risk-free assets. So you have a confluence of factors, basically, that led everybody stuck into the very same trade. And then at some point, banks were like, yeah, but I'm not making any returns. I need to enhance my returns on the asset side.

How do I do that? Either I run more risk, beta risk, so more credit risk at the end of the day, or I'm going to run more proactive strategies, try to generate some alpha. And this ties in all with the LDI. It seems the same thing was going on in England there, right? Of like, okay, we need a little more return. Let's either expand our duration or add something on top. So you were personally one of those pieces that got added on top saying, hey, Alf, make us some more money. Yes, pretty much. And look, the environment was very challenging. If I reflect on it, going back in the past, 2019 was a year, for instance, where if you were a beta investor

and you just bought some bonds and some stocks, took equity beta risk, bond beta risk, went to sleep, did absolutely nothing on it, Jeff. You made a sharp of, I think, two. I'm like, sorry, what? If I look back, I'm like, wow, simply by allocating capital passively into beta risk in bonds and equities, you made a killing in risk-adjusted returns, which meant, well, okay, so if I'm asked to generate alpha, how do I feel about that, right? I mean, I'm supposed to generate more return by taking the same amount of risk, right? So I'm trying to make some returns which are either not like diversified against this beta or more returns taking the same amount of risk. And back then, actually, it was very hard.

I remember that trying to squeeze the last basis point of carry, of risk premium available, was the name of the game. So you sold volatility, you sold tails, you tried to generate structures that were somehow harvesting the very little risk premium left. If you reflect upon it, it was a massive selling of tails, very concentrated. Everybody was having the same trade on, which then in early 2020 with the pandemic and the

exogenous shock, it turned out to actually be quite a problem, right? I don't think that's very different from what we have seen now in the bond market, Jeff, to try to make, to contextualize this. Narratives in global macro can be really strong. Up until three weeks ago, we had, I think it was the best setup ever, or almost, to try and have some bond exposure on your book. Why? Because nobody wanted bonds anymore. Everybody hated bonds. And nobody thought they would need them anyway in the near future, because the narrative was Fed funds above 5% forever. The economy can run with much higher interest rates. Inflation is really sticky. Powell is very serious about it.

And the positioning was also interesting. Many of my clients are high caliber macro hedge funds out there. And unfortunately for some of them that have taken some hits, when you want to try and play for higher Fed funds over time, what you do is you do collars, you do put spreads on on sulfur, put spreads on Eurodollar. All of these require you to pay premium upfront, but the hedge fund business is not built on bleeding premium while you wait for an outcome, right? You are supposed to find structure that doesn't cost you money and pays off in a convex way if you're right. So what people thought is, I'm going to sell some coats against this. That didn't turn out very well,

did it? I mean, there was such an explosion involved at the front end of the bond curve, which again, is the result of such concentrated global macro narratives. They have become quite a feature of the system, I think, rather than a bug. Stig Brodersen And selling calls on the bond price, So basically selling puts on the yield. Correct. Yeah. And to me, that's a kind of a, you're saying the same thing as the old line of whatever causes the most people, the most pain is what the market's going to do, right? So from a professional standpoint, that was for sure. A lot of the sock gen trend index had its worst five day ever uh a bunch of trend followers we track were down between five and fifteen percent in two days

right on the friday and the monday um because they were yeah they were short euro dollars two years five years ten years thirty years they're just short across the board um which had paid out in spades over the last two years. Some of those trades have been held for 600 days by the trend flow. Wow. Well, of course, if you're a trend follower, 2022 in rates was amazing, right? It was one trend up, very the retracement above, you know, that basically made yields break down the moving averages, the, you know, the trailing bands that you use in these strategies. It was the perfect environment to run your profits for long in short rates. But the consensus was overwhelmingly, I think at some point,

moving towards this higher for longer thing. While Jeff, on the other hand, I think we had gotten already quite some strong indications that we are late stage in the macro cycle. And especially certain sectors that have relied on a continuous flow of credit between 2014 second the conversation on the real estate just to show how important is that asset class to the overall global macro landscape. First of all, the real estate market is the biggest asset class in the world by market cap by a large margin, Jeff. If I would ask people like what's the biggest asset class in the world, they would normally say the bond market.

You have to take the bond market globally, sum up the stock market globally, and still you are not at the market cap of the real estate market. It's really gigantic. And it makes sense, right? I mean, it's something that people need to live, right? So it fits the needs of people. It's a very leveraged market. Mortgages back up about 80% of new house purchases in developed markets. So it's a very leveraged market by definition. And it's systematically important as well, systemically important for- And so what's that number look like?

50 trillion or something? No, no. It's like over $200 trillion. Okay. It's just huge. I was just happy I got the T right, the trillion, right? So just the Chinese real estate market before the deleveraging we saw in 2021 and 2022, just the Chinese market was $50 trillion, one real estate market. So that's the size we're talking about. Now, let's reflect on the fact that, as I said before, many pension funds, insurance companies, banks were looking for yields between 2014 and 2021. So what they ended up doing is they took more leveraged exposure to the sector, right?

Meds and entranches, commercial mortgage-backed securities, residential mortgage-backed securities, anything that gave them leveraged exposure to the real estate market. So the flow of credit to that real estate market was actually very ample and very good for a long period of time. That has come to a sudden halt. The real estate market is frozen. I mean, housing sales are down 30%, 40% year on year in the US. I mean, the level of activity in the housing market has come to a halt. New buyers are cut out of the market, Jeff. I mean, it's unaffordable for many at this level of mortgage rates. Sellers, on the other hand, are on strike. They're not going to sell because they're locked in mortgage rates at 3% for 30 years. Nobody's going to willingly give that away. There you go, Jeff. You're not going to sell unless you are really forced to, right? So unless

there is a deleveraging event or something where you need to tap into that built-in equity, you are not going to sell. Something along these lines. A labor market cracks, I don't know, something big. I have a quick anecdotal thing for you. In February, down at iConnections at the hedge fund conference and had 15 private credit meetings my takeaway was they're all doing mezzanine debt on commercial real estate projects right and the answer was well what happens in a big crash and the you know your you can't get your money out oh well then we take possession and usually we actually make more when that happens um so there was this kind of, yeah, rose-colored glasses for sure. And that was just in early February. There you go.

So this anecdotal evidence feeds into this narrative. And look, the housing market is frozen, I think is the right definition. It's not collapsing, but it's frozen. It's just on stasis waiting for something to happen. Before the banking stress, which we're going to discuss about as well, there were some clear signs that the stasis was about to be resolved on the way down. So Blackstone and KKR, the two largest institutional investors in the housing and the real estate market, had a gated redemption on their largest real estate investment. That's never a good sign,

right? Where you basically say, look, investors, I don't want you to withdraw because if you do, I'm going to be forced to liquidate my assets and liquidating my assets in this market where there are no marginal buyers might actually be very problematic. So what you do is you try to limit your redemptions, right? I think it's still gated, the Blackstone one, last I read. Yeah. Not good, I would say. And the second is Blackstone defaulted on the first CMBS, over $500 million. It's not a huge deal, but it goes to show that on the commercial real estate market, especially if you cannot get this cash flows coming in from offices, from stores, because vacancy rates are lower, at some point you'll need to sell the collateral to meet your investors' demand, right? But you find no buyers.

There is no marginal buyer at these prices. So we had some signs that the stress was building up in the sector, Jeff. But nevertheless, people were so deaf to this and so strongly seduced by the narrative of higher for longer that they were selling calls on bond prices. I guess this is another episode that goes to show how important it is, how powerful narratives in global macro can be, and maybe the edge sometimes from a global macro manager can be the ability to detach from the narrative, step back, have a data-driven macro process, and try to see where the market is willing to overpay or particularly depressed and underpay

for tails. I think having that assessment is really still some edge available for global macro investors out there. Stig Brodersen And so you're saying these funds, for lack of a better term, were saying, hey, I'm willing to accept that tail. I'm willing to accept that rates aren't going to rise 120 basis points in the five years, whatever they did over two days, right?

I'm going to accept that risk because we're higher for longer. But was that whole real estate problem driven by COVID? Was that the vacancies or driven by higher rates and there's no one wanting to come in and do a new deal, a new project at the higher rate? Yeah, it's a combination of both, right?

I mean, cash flow deterioration comes because of vacancy rates being lower. But then from a credit flow perspective, that's the real problem because such a leveraged market, Jeff, in order to keep running needs a very robust flow of credit, of cheap credit being thrown at the system. And the credit wasn't ample anymore. Lending standards were tightening aggressively already before the banking stress. And on top of it, it wasn't cheap anyway because these lending rates, because of risk-free rates higher, but also credit spreads wider had basically the resulting effect of having these credit flows being much more expensive. So you have tighter credit, more expensive credit, and that generally

hurts any leveraged market that relies on cheap credit in the first place to keep running. Stig Brodersen And it seemed everyone was perhaps the lag effect or whatnot, right? The narrative for a long time was, oh, they can never raise rates. It'll break everything we're saying. It'll break real estate, the biggest market in the world. And then they did raise rates and things weren't breaking. So that's where everyone went, oh, this can work. We can be higher for longer. Stig Brodersen That's the point. I mean, I think there was a point last year where people were in denial and they said, look,

Fed funds can never be above 3%. Something's going to break. That narrative was also strong. So that's why trend following on rates worked extremely well because there was not a major participation, fundamental participation, which meant the path of least resistance was that rates kept pushing higher and higher and higher. It didn't become crowded until, funnily enough, you were at 5% Fed funds priced in for 18 months to go, Jeff. If you reflect about that, tightening in financial conditions

hit a credit-driven system like today's economy under two circumstances. When there is a rapid increase in borrowing rates, then you get a shock effect, right? You get a repricing of valuations because risk-free rates all of a sudden are much higher. So you have this shock effect. The second effect, which people really underestimate, I think, is the length of tighter financial conditions. For how long are you going to keep rates at 5%? And at some point, the market was pretty convinced that the economy could basically run fine

with mortgage rates at 7% and corporate borrowing rates at 8%. But actually, the fundamentals don't justify that, Jeff, because after the pandemic, it's not like the ability to generate cash flows has gone up structurally by 10 or 20%. It hasn't. It hasn't gone up structurally by 10 to 20%. It just means borrowing conditions are much tighter. And if you keep them tighter for longer, sooner or later, some issues are going to come to

the surface. And I wanted to share a quick chart that you shared. This is one of my favorites. We're terrible, I'm going to own the futures market here. Us people in the futures market are terrible, terrible at projecting where these rates are going to go. So for listeners that aren't on YouTube, go check it out on our YouTube channel. But at the same time, this is that famous squiggly chart, I call it, of the projected Fed funds rate and the actual Fed funds rate. Stig Brodersen Look, I mean, people are, again, there are so many well-believed narratives.

One of it is the bond market always knows, right? It knows something smarter than any other market. I've traded a large amount of bonds for a long period of time. What I can tell you is the bond market has a lot of informational value, Jeff, in its nuances. If you're able to decompose real rates, inflation break-evens, forward rates, implied vol, credit spreads. I mean, the bond market has a wealth of information that you can try and use in your process. But its predictive ability, that's a different story. I mean, in October 2021, the bond market, looking at one-year forward rates, was expecting

Fed funds to be hiked by 25 basis point in 2022. The Fed hiked 475 basis point in 2022. Inflation break events, one year forward, one year inflation break events in 2021 were 2.5%. Inflation ended up 2022 at something like 8%. So obviously, the predictive ability, as also that chart showed very clearly, is debatable. So you shouldn't rely on the bond market to know exactly what the future holds, but there is a lot of information or information on value in the nuances of the bond market that you can use in your process. Talk a little bit about that because most people who listen to here and to quants and systematic strategies, everything you're doing is trying to give discretionary and correct me if I'm wrong,

but kind of discretionary macro traders, the tools and the information, like you said. But here we just showed a chart of this information can be incredibly, not misleading, but incredibly non-predictive. So how do you balance and how do you weigh those two of how do people use this? Is it up to them to use it correctly? So Jeff, look, what I do is actually a bit of a mix of both. So I have a macro process that relies on data. So from a certain perspective, it's quite systematic. The decision-making when it comes to portfolio investment ideas that I send out to clients is obviously discretionary in nature, but the risk management behind it is very systematic. The sizing of the positions, the portfolio correlations. So it's a

blend basically of discretionary ideas coming though from a pretty systematic macro process with a pretty systematic risk management behind. A bit of blend of both. Said that, there is quite some discretion, right? At the end of the day, I'm not going to lie. So look, the discretion comes from being able to piece a lot of things together because global macro is vast. So you need to be able to get information from a lot of places and bundle them together and try to sort the puzzle out. The nuances of the bond market are very important. For instance, take implied vol in the bond market. It's something that is quite important to analyze.

Let's take today. Implied vol in the front end of the bond market, say one year, two years options. So basically the implied vol in price in the next year for two years swap rates in the US, annualized. Wow, it's running at very elevated levels, really elevated levels. So what does this tell me? Two things. A, people have degraused pretty aggressively because once you price away that kind of wide outcomes, it means you're not taking many risks. The amount of risk premium price there is so wide and it's not compressing

for weeks now that it means a lot of people have been hurt because they don't have the capital, the VAR, the balance sheet, the ability to come in and compress this risk premium. Right. Because in other environments, they'd look at that and be like, oh my God, this is so fat and juicy. We need to get in there and sell. Correct. But now because we're reading, actually the bodies are coming to the surface, right? I mean, we see the casualties in several hedge funds that unfortunately were caught into this deleveraging process. The fact that implied vol stays that wide for so long, it's telling me people are eventually de-risked. So that's

the first information. Second part, institutional investors' behavior driven by implied vol. So the bond market is at the epicenter of our system. The treasury market is the most systemically important out there. It underpins repo markets. It underpins collateralized lending in general. So the treasury market needs to be strong and stable in order for other things to work. It's like the base of the pyramid, right? If you have daily moves of 20 basis point plus minus in two-year rates, Jeff, this is a byproduct of implied what we talked about before, right? It is very hard for institutional investors to take risks down further down the curve if the very asset which underpins the stability of the system is so unstable.

So both implied and realized in the bond market can tell you something about the ability to take risks, both from the hedge fund community and institutional investors community. And actually, even if you look at some relationship, if you look at bond vol against multiples, against credit spreads, against high beta assets, you'll tend to see some good relationships. When bond vol is compressing,

when things are calming down, people can lever up again, take more risks, and they'll do that when there is more risk premia available. So understanding these nuances can be very important, can inform your process. Of course, it's not the only thing that matters. Macro data also matters. Sizing also matters. Correlations also matters.

But what I try to do is put all of that together in one big box of global macro allocation and see what comes out of it. And we'll come back to that, but speak for a minute on what that box looks like. There's actually, at first, when you left the bank, you were doing just a newsletter, Twitter. Then that South of Italy lifestyle, you said, hey, we got to put out a subscription service. So tell us what that box in your words looks like well first of all uh i wish i could have a southern italian lifestyle because i actually work much longer hours now than i did at the bank running money can't imagine what kind of work it is to set up all of this but it's been fun and it's good. A lot of people have subscribed, which makes me happy. And also right now, Jeff, I mean, it's like before I was running Money for the Bank.

Nice. Now I can try to make a bit of an impact. You know, if I'm not always right, not at all. But I can try and convey my experience to a broader range of people while before it's compliance and you can't go on an interview and you can't see this on social media and all of that right now it has a bigger social impact which is good i like that part said that um look when i quit my job from the bank um i thought i'm going to be a consultant only for certain counterparties i knew already from my

previous job it actually started like that. Then I realized that, well, there is quite a lot of appetite from people. They want to learn what I have to say, or they find it interesting, right? Or maybe the way I say it, I don't know. So I went on social media and then the Twitter profile just exploded. And then I thought, well, it's quite a lot of people interested into that. Turn it into a newsletter because I can write longer form pieces, more charts. A tweet is very short. It's very hard to elaborate on a macro thought in a single tweet, right? So I moved it up on a newsletter, even more response there.

And at some point I thought, I'm only writing stuff, but people need more. They want to have tools like the same stuff that I use to look at ball-adjusted returns in markets, try to connect the dots, regress, find anomalies, generate trade ideas, look at what portfolios I am building. And again, everybody has its own risk appetite, but I wanted to make it more actionable. I wanted to give interactive tools, research more often. So I ended up building a whole platform that does that which is called the Macro Compass

where all of that is available so not just the newsletter you get my research pieces but there is also much more behind including interactive tools portfolio strategy tactical trades and all of that

and that's macrocompass.com? yeah the macrocompass.com is the website. Go check it out. That's awesome. I will subscribe. I'm not yet a subscriber, but we'll check it out. Thanks, Jeff. And that comes back to my feeling, though, just, okay, is it a net?

I mean, you must believe it's a net positive for those. I'm kind of trying to separate my brain between retail-type investors and hedge funds that might use that tool. We'll start with the hedge funds of like, is it really some guy sitting in a pod shop who's going to subscribe, read that stuff and be like, oh, okay. I hadn't thought of that trade. I'm going to do that. Do you think there's those people out there? Yeah. Actually I can see them subscribing, which is good. Look, there are different tiers of course of service, Jeff. So there is a very high level tier for pro investors, right? That basically covers their needs more. It tends to talk more about trades that a professional investor can put on and a retail investor instead will have a hard time

trying to replicate. Right. Like credit default swaps or swaps or things they can't actually. Is that kind of trades, right?? Not always, but in some case, they will be peculiar to that kind of client. So it caters for the needs of a professional investor, let's say. Then there are tiers that are more of a hybrid, let's say. So you still get very high quality research, but also it maybe looks at an ETF portfolio, for instance,

an expression of that, because it's tradable from anybody really really in case they wanted to try and understand what am I doing from an asset allocation perspective, they can. So really there are different tiers based on what kind of investor are you, but the philosophy behind is the same for everybody. It's like, look, I have a data-driven macro process. I do a lot of work. I put it all up together. Try to do this in plain English. I mean, okay, Italian accent, sure, but I can't take it out. But what I mean with plain English is I don't like overcomplications, Jeff.

Like, you know, there are a lot of people in our business. They try to sound very smart. Nobody understands anything what they want to say. For me, it's different. It's like, I have an idea, data-driven driven i back it up with charts and i pass it over and then look i might be wrong i am wrong by the way that's the other thing i stop out publicly i have no problem admitting an idea was wrong just do the hard work put it out apparently many people find that very useful maybe also because i'm independent i mean look if I've been in the bank. You have no agenda.

Yeah. Yes. I know the kind of pressures you can get working for large institutions. You can't say that. You're supposed to back out this thesis. I am supposed to do nothing. I just look at the process. I have the data.

I have the charts. I put it out. I have no agenda behind. And it seems to be something people appreciate. Stig Brodersen Yeah. And then to me, just if you don't take every signal, it's one signal, okay, but whatever. Let people give them the tools and let them deal with it as they would. Let's backtrack and just everything that's happened since Silicon Valley Bank came on the radar. What are your biggest takeaways? What's the biggest emergence out of that?

That's a good question. So we need to back up and try to do a level-headed analysis. There is so much fear-mongering out there. Oh my God, this is systemic and something's wrong. Again. Okay, so let's take a data-driven level-headed assessment. Silicon Valley Bank went down

because of three things. Under-regulation, and that can be a systemic problem because the $200 billion bank in the US, as I will explain, doesn't need to stick to a lot of regulation, which means regulation is pretty lax for small banks. This can be a systemic problem, right?

But also it went down because it had a very concentrated funding base, and that's a risk in the first place. And it coupled that with horrible interest rate risk management, or in general, non-prudent, let me say, to say the least, interest rate risk management. So this was the trifecta that led Silicon Valley Bank to go belly up. All right, so how many other banks in the US have such a concentrated funding base coupled with horrible risk management on the asset side? The answer is maybe a few, but if you want this to become a systemic crisis, then what we are discussing about, Jeff is, can this be a systemic liquidity crisis? Because that's what it is. Depositors go away. Your liabilities fade away. Your assets must shrink. So what do you do is you sell your assets to try and raise money to meet your deposit

outflows. If you want this to cascade into a broader liquidity event, it must mean two things. A fire sale of safe assets, the very safe assets that regulators force large banks to have. Yeah, which is a mismatch. Correct. A fire sale of these assets, which is not met with an unwind of swaps. Because ladies and gentlemen, a prudent bank doesn't buy,

like Silicon Valley Bank did, 60% of their assets into mortgage-backed securities and treasuries and does not pay swaps against that. That's completely nuts. You're running just an oversized amount of interest rate risk that is just not prudent. Which comes back to where they were thinking higher for longer.

I mean, but it's just ridiculously risky to do that. So two things here to say, for which I think that this cannot and will not turn into a liquidity systemic crisis. We'll talk about credit risk later. Let's talk about the liquidity part first. A, large banks, take JP Morgan, for example, Jeff, they provide you with an analysis of what is the capital hit that they take if interest rates are going up 100 basis point. Then the curve is flattening and all the adverse scenarios you can imagine on interest rate

risk. And mind, Jeff, they don't only look at bonds, which represent 15% of their balance sheet, they look at the entire balance sheet because a bank exposure to interest rate risk also comes from long duration liabilities, long duration assets, swaps that are used to mitigate the risk. So the bank looks at the entire balance sheet and they say, what's my net duration exposure? What's my net DVO1 impact of this based on my capital? JP Morgan did that and estimated that a 300 basis point move higher in rates

and a 100 basis point flattening of the curve, which is basically what we have seen over the last year and a half, wipes out about 8 to 10 billion of capital of JP Morgan. Sounds like a huge number. JP Morgan's capital is $270 billion. So a 4% to 5% wipe out of capital, not a small hit, not an existential threat. But that's after their hedges are in place, right? Yes, after their hedges and considering as well the entire balance sheet, liabilities, assets, and hedges. So that's about 8 to 10 million. It's 4 to 5% of capital. If I do the exercise in Europe, where we have much tighter regulations, stress tests, mandatory stress tests on interest rate risk that the US does

not have, which I find interesting. But if I do that on Europe, where I have broader data, not only for JP Morgan, the typical European bank takes a hit of about 5% to 6% of capital. Again, quite a significant hit, but not an existential threat. So that's my first message to you guys. A lot of fear mongering out there. Take a step back. Look at the stress test.

Look at the data. It's available. It's a negative for the banking sector, but it's not an existential threat. Second point. Well, Alf, yeah, but what if banks are really forced to sell down these treasuries because they need to meet the deposit outflows? What if it turns into a confidence crisis that people take away their deposits? Okay. So let's think about-

Where everyone runs to JP Morgan because they just heard you say, JP Morgan's fine. Yeah. But okay, let's take a bunch of mid-sized bank under pressure. This can easily scale up into some widespread crisis. The Federal Reserve has weapons to fight a liquidity crisis because what they did with the regulators in 2013, after the great financial crisis, they said, dear banks, you can buy treasuries, you can buy mortgage-backed securities. We will basically treat them as cash for regulatory perspective. No liquidity haircuts, basically no capital as well to attach against possible losses in these bonds. We'll assume they're as cash for regulatory purposes. Now, in a hiking cycle, the market value of these treasuries,

if you didn't hedge them, it's 80 cents on the dollars. So it's not as cash. Sorry, but it doesn't work like that, especially if you're forced to sell them down. What the Fed did right now is set up a facility, the Bank Term Funding Program, that basically restores that sentiment, that confidence that the value of the collateral, the treasury collateral value

is a hundred cents. They don't care if it's trading at 70, 60, 80. They don't give a crap, Jeff. It's a hundred. If you post it at the Fed, you'll get funding for a year at Fed funds plus 10 basis points, which is not cheap funding overall. I mean, it's over four and a half percent that you pay for your funding. It's not like a deposit at 0%, but there was good times. They're now gone if you're a vulnerable bank, but you don't need to fire sale treasuries. This is the same backstop that the Bank of England put up when the pension fund crisis was there, where this pension fund had government bonds, but they had to meet collateral margin calls from their derivatives.

And they were fire selling these bonds, which were exacerbating the problem. And it was a widespread panic. So what the central bank did is, don't sell these bonds, please. Actually, give them to me. I'll lend you money. Use that money to meet the margin call if you need to meet the margin call. It's a very similar mechanism. Yeah, just the US driven by depositor outflows and Europe driven by derivatives.

Correct. It's a very similar circumstance. The Fed has weapons to backstop the liquidity side of things. That's the first important thing. Interest rate risk at the bank level, it's a hit on banks' capital, but not an existential threat if you run the numbers. Second, even if more banks are forced to meet deposits outflows, they can now post the treasuries at the Fed. They don't need to fire sell and start this snowball effect. Okay. Level-headed. These are the data. This is the stuff going on right now. Does it mean it's all fine? Well, it's a bit of a different story because some banks have mismanaged their risk, Jeff. I mean, some banks have acted a bit like cowboys. They've taken excessive risks. They have

a very concentrated funding base. So what I think here is happening is we'll have a bit of a bifurcated system where overall, systemically, the liquidity stress will not turn into some catastrophe, but it's going to be a bifurcated environment where people are looking for the safest forms of collateral, the safest exposures, TBIOS, money market funds, deposits at JP Morgan, not deposits at the community bank. They don't know which kind of risks it has run. Why would I keep my money there? Because I'm not rewarded for it in the first place. So that's a bit of the bifurcated system and long-term macro impact of that is you're drying up funds and credit for the weakest balance sheet exposures out there. Those are exactly the kind of entities that need flow of credit for the economy to run. So overall, what should-

Is that deflationary? Is that where you're getting to? It is. So medium term, any banking stress, Jeff, is disinflationary in nature because it forces the banks to deploy their capital, their resources into surviving, into strengthening their balance sheet, into strengthening their liquidity position, and not into lending to the real economy. So the flow of credit dries up. And when the flow of credit dries up further, on top of what it was already drying up because of the macro cycle we are in, it just compounds the disinflationary forces that we're about to hit anyway.

Do you, sitting there in Europe, kind of have a little cheer of like, oh, the US banking system for once instead of us? Look, I always say we in Europe do a lot of things in a suboptimal way, undeniably. But on regulation, I think we did a bit of a better job. I mean, look, US regulation for banks below $250 billion, it's very lax. It's very, very lax, Jeff. They don't need to stick to net stable fund ratio, to net stable funding ratio, to liquidity coverage ratio. They have a lot of exemptions. I don't particularly like that because $250 billion is not a small bank. Let me give you some perspective.

In Germany, if I take a top three bank in Germany, its balance sheet is less than $200 billion. Top three bank in Germany. So 250 billion is not a small bank by any means. So this regulatory environment, which was lux for them, is actually a mistake. I think it's going to be repaired now. Regulation is going to get strengthened, of course, because regulators are great at admitting they were wrong after the fact. They're really good at that, but preventing, not so much. And in the US, the other thing is, I mean,

you guys don't have a mandatory stress test on interest rate risks on banks. I find that unbelievable. JP Morgan willingly reports the numbers I told you before, but not because there is a stress test. In Europe, there is a mandatory stress test called supervisory outlier test on interest rate risk, where each bank has to stress their balance sheet, assets, liabilities, hedging instruments, everything, and report every quarter what would happen if rates go up to one basis point. So the regulator can check. Stig Brodersen

And that would force a bank like SVB into those hedges and whatnot. So you can either say you have to have hedges on or show us your stress test. And if you fail it, you have to have hedges on. Marco Cappellino There you go. So yes, it's a bit of a vengeance for Europeans. No, I'm just kidding. But it's one of that moments where you're like, okay, for once, we did something in a more stable way than the US.

That's quite a news. Let's touch quickly on Swiss, Credit Suisse and the Swiss bank changing the law, essentially, is that a moral hazard of like, okay, we're going to, central banks, central governments are going to start choosing winners and losers and one, like we already said, if it gets bifurcated, if I'm a small business

and I can't get in, JP Morgan eventually is going to say you have to have $100 million and XYZ. I've already seen that in the hedge fund space. They'll kick out funds that are under 100 million. Look, Credit Suisse, that was an interesting story. The timing was interesting because it had nothing to do with all this banking crisis in the first place.

It was about to die for 12 years and it finally died at the most inconvenient moment. But look, this is another byproduct of low and negative interest rates is people investing in these additional tier one bonds without probably reading the fine print, because Swiss regulation is one of the few in Europe that allows for what's called the permanent write-down of additional tier one bonds, which means if the regulator deems that you have hit the viability trigger, so basically the bank's about to go belly up, under Swiss regulation, the regulator can choose to write down completely additional tier one bonds, which they did. There was also a political decision, I think, to prefer certain equity owners to certain credit owners, but the regulator could do that looking at the fine print of the bonds. People have been quick in extrapolating how the

additional tier one market in Europe is dead because now everybody is basically subordinated to equity owners. Why would you own a bond? Just own the equity, right? If that is the treatment. The reality is this permanent write-down clause only exists basically for the Swiss market. So the broader European market cannot operate this way. Regulators couldn't trigger down

and write down completely the additional tier one holders. So again, a lot of emotional feelings going around, I think, in markets. This was a pretty interesting choice by the regulator, I think, but it was allowed. It was nothing, how can I say, completely out of the box. It was quite a decision anyway, which people are extrapolating.

It's valid for the overall European market, but it's not. I've just seen the headlines, haven't into it of like they changed a lot. You're saying it pre-existed. No, they didn't change anything. They just took a very harsh decision based on a clause existing in the fine print of these additional tier one bonds. So I want to throw everything we just talked about away, right? We can kind of get trapped into like, oh, this bank and rates and everything like the world throwing all that away. What's kind of off the radar that's massively important that's either bubbling up through

your tools or your brain or tell us some things we're not thinking about. I would say, I'm going to say China. And people are like, yeah, of course, we're thinking about that. Yeah, in general, you were only thinking about that, right? I mean, the only topic of discussion was China. It makes me think about the Barron's newspaper front page that said, this is the moment to invest in China and it marked the local top.

I mean, this is always the thing. When a big newspaper comes out with the front page, you know you've got to take profit, you know. But nevertheless, now nobody talks about China anymore. It's like nothing is happening. The reality is that China has gone through a massive deleveraging in 2021 and in 2022. Xi Jinping decided that the euphoria in the tech sector and the real estate market in China was overdone, and that he needed actually to rebalance the economy and take away some of this excess optimism from the sectors. He did so. I think he didn't expect that sort of the leveraging, so he was a bit too optimistic.

Again, the Chinese real estate market, $50 trillion worth, took a major hit in 2021 and 2022. As people also were locked home in China, basically with a nonstop lockdown for almost three years, the confidence was pretty low. But actually in October, November last year, things started to change pretty rapidly. We got the first verbiage that China stands behind the real estate market. It's going to try and stop the leveraging, more friendly measures being taken, most importantly, credit being thrown at the economy already from mid-2022. It didn't result into stronger growth already, Jeff, for a very simple reason, two reasons. A, it takes time for credit to feed into economic growth. There is a bit of a lag, a few quarters normally. Second, people were locked home. So you can give them money,

cut taxes, do whatever you want. But if people are locked home, it's going to be very hard for that to feed into economic spending and economic activity. That's over. China has now basically stopped lockdowns. And it's very clear the direction of travel is towards reopening. And there is pent-up demand coming from this credit stimulus that is sitting now on the balance sheet of corporates, on the balance sheet of consumers. So yes, the reopening is happening. It's there, although people don't talk about it anymore, but it is something that goes under the radar and it can be quite a force, I think, for global macro overall. And I think people have just forgotten about it.

And now the only thing any client of mine wants to talk about is banking crisis, Fed cuts. And I find this interesting. Stig Brodersen But that seems like that's inflationary versus all these deflationary forces from the banking. So you have competing factors. And then how does it work if China can do whatever they want with rates, but if the rest of the world's not buying their cheap goods and stuff, there's

an issue there if it doesn't really matter what they do internally. How do you square that? Look, it's a valid point. My point is that I do not expect this to turn into a liquidity crisis, snowball effect where a recession is hitting tomorrow. I think the path of least resistance is that no bank goes in receivership at the FDIC over the next two to three weeks, maybe some very small bank, but most of the damage is over, which means that if you paid massive premiums for these insurance trades, you're going to wind them down because why are you bleeding carry if nothing is happening, right? That's what normally happens.

What this means is slowly but surely, markets can try to focus back on the macro rather than on this banking drama. And so the Chinese reopening is inflationary, and it plays a little bit into that theme. I think we're moving from excesses. I mean, Jeff, it's been push and pull in macro in 2023. It's going to be like early 2023. It's this inflation everywhere, but Chinese reopening. So just buy Chinese assets.

February 2023 to early March. Oh, it's inflation back again, it's economic activity back again, stronger dollar, higher for longer, sell calls on bonds, extremes there again. Now it's like, it's over. This is it. 100 basis point of cuts being priced this year. What? It can happen. Sure, it can. But you really need to be sure about a credit crunch, a recession hitting anytime soon for these cuts to be validated,

for these forwards to be validated. I think there is a chance that we are doing extremes again here. And maybe if this situation calms down a bit, plus the chain is reopening, you might want to see another rebound up towards the macro trend of, well, we're not in a recession yet. Well, the Fed actually needs to do a little bit more and you can actually basically fade this extreme. I think there is a chance. You should consider it as well as a trading environment here. Why are we jumping to these extremes? Is it because of more automated trading?

Is it humans have become less patient? It seems like no one has had the kind of level-headed thought you just said of like, well, we got to consider all sides of the coin. It's just like, nope, rates cuts are back on. We're going to hammer it down. Jeff, I think, look, the structure of the system and the fast money industry in general, but not only that, also institutional investors with a benchmark to beat basically are effectively forced to make money every month and every three months. That's how the system works. I mean, you can't have two bad months in a row. If you're trading for a macro hedge fund and you're down 3%, you're fired.

That's how it works. So the incentive scheme is basically to chase trends and narrative, even short-term trends and narratives, to try and stay on board with the shiniest new object in town. And now the shiniest new object in town is banking crisis and Fed is going to cut rates by 100 basis point. And in general, it was China. So this leads maybe a little bit to this reflexivity mechanism where people try to just chase screens and headlines. And it's also, I think, by design of having to chase these returns, monthly returns, quarterly returns, very short and oriented returns.

This incentive scheme prevents people to a certain extent to take a step back and say, do I really need to chase narratives right now? Yeah, I think that creates a huge negative skew return profile overall, right? Of like, everyone's going for these quick, consistent gains. It creates the underlying tails and say, hey, you're ignoring the big thing that could be happening at the same time. Look, the interesting thing is that

people have been using tails and they understand this return profile. So in some cases, you'll find tails are not particularly cheap as a way to hedge against that because people are using it, right? It's a way to say, yeah, if I have to be in this game, I'd rather buy some tail risk protection as well because it helps smoothen my risk profile. There are situations though where the narrative becomes so harsh and entrenched that even tails become very cheap. And I really like,

especially in volatile macro environments like now, to try and exploit these opportunities. This was, for instance, the case where you could buy, and I did at the end of last year. This was ridiculous, I think. You could buy a cold spread on software June 24. So we were looking like one and a half years ahead, quite a lot of data ahead of you to try and make money. You were buying cold spreads on software with Fed funds

below 2%. So priced for a recessionary cut cycle, basically. And you would be looking at a potential payout of 7X, 8X. You're like, okay, this is a tail. It's not easy to have all these cuts

from 5% to 2% in 18 months, but I'm paying 12.5 cents, 12 cents, and I can get 100 cents back. It's 8x payout. So sometimes the narrative becomes so entrenched that tails become particularly cheap, especially in environments where macro is very volatile, and so these tails can actually realize. Love it.

All right. We'll leave you there. You got to go enjoy the beach or something fun. Have a great weekend. Tell everyone where they can find you. Twitter is at MacroAlf. Correct. Twitter is at MacroAlf.

But Twitter is a place where you give snippets away and you maybe post a pizza picture because I'm Italian after all. But the good stuff, the macro research, the data-driven process, the trade ideas, the tools and everything I use and I give away to my clients is on the macrocompass.com. There are different tiers for different pockets depending which investor are you,

a rather sophisticated retail investor, a professional investor, but the mentality is always the same. Do the hard work, data-driven macro process, explain it in plain English, give away tools, investment ideas, portfolio strategy, and let's try to generate some returns together. Let's do it. Do you have a best American pizza? Is there an American pizza? There you go.

Just kidding. No, I've been in New York and I've eaten one. Actually, I should say maybe three because a New York pizza is at least three times as big as an Italian one. It's huge. I actually didn't find that to be that bad. But if you want my standard quality pizza in the south of Italy, you go on my Twitter profile, you check what I've posted a few days ago, and that's it.

That's the one. It looked good. Looked fantastic. All right, Alf. Thanks so much. Have a great weekend. We'll talk to you soon. Thanks, Jeff.

All right. Okay, that's it for the pod. Thanks to Alf. Go check out his new service. Thanks to RCM. Go check out their rankings. And thanks to Jeff Berger for producing. We'll see you next week in the Oil Patch.

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